A bullish breakout for natural gas

Key points:

• Natural gas futures closed at a 6-month high but not a 9-month high, completing a base breakout
• Similar breakouts after a 1-year low led to an 80% win rate over the subsequent three months
• Despite the outlook in the commodity, natural gas stocks failed to participate in the upside

A potential bearish to bullish transition in natural gas 

Natural gas experienced one of the most severe drawdown periods in history, as its 1-year rolling return plummeted by -76.82%, second only to the -77.25% decline witnessed in January 2002.

When assets experience a significant drawdown phase, they often go through a healing process. The market tends to move sideways for a while before eventually shifting upward to usher in a new bull market. Justin Mamas called this process the sentiment cycle.

Last week, natural gas closed at a new 6-month high but not a 9-month high, completing a base breakout pattern after a significant drawdown period.

Despite the rally from the April low, the 1-year rolling return remains at a level suggesting bullish annualized returns.

Similar breakouts suggest natural gas can rally further

When natural gas completes a base breakout pattern after a 1-year low, returns are somewhat uninspiring in the first month, suggesting some backing and filling could occur. After the pause, performance picked up, with the commodity rallying 80% of the time over the subsequent three months. The six-month outlook should act as a reminder that nothing comes easy when it comes to natural gas. 

The max median gain exceeded the max median loss in 8 out of 10 precedents, with some showing significant risk/reward profiles. 

Natural gas stocks

Surprisingly, the returns and win rates of various natural gas stocks appeared lackluster. Therefore, it might be wiser to consider an allocation to the physical commodity itself, a task made accessible through an ETF like UNG.

Seasonality

If history rhymes, seasonality should provide a tailwind for the next several weeks.

What the research tells us...

Natural gas trading is not for the faint-hearted. After enduring the second-worst one-year rolling return period in history, natural gas spent most of this year in a sideways pattern, slowly recovering from the damage. However, a significant development occurred just last week when it soared to a new six-month high, hinting at the possibility of a transition to an uptrend. Similar breakout patterns for natural gas saw gains 80% of the time over the ensuing three months. Interestingly, natural gas stocks remained on the sidelines while the commodity rallied.